Dutchess Community College

ACC 204 – Managerial Accounting

Quiz Prep Chapter 5
Cost-Volume-Profit

Peter Rivera
March 2007

Disclaimer

This Quiz Prep is provided as an outline of

the key concepts from the chapter.
It is not intended to be comprehensive or
exhaustive.
Quizzes may include material from the
classroom lectures, the text or the homework
assignments.

ACC 204 Chapter 5 1

 Cost Behavior Analysis

Cost Behavior Analysis is the study of

how costs respond to changes in the level
of business activity.

There are 3 categories of cost:

• Variable; e.g., direct materials

• Fixed; e.g. rent
• Mixed; e.g., truck rental

Variable Costs
Total Variable Costs Variable Costs Per Unit
vary directly and do not change with
proportionately with activity level
changes in the activity level.

Total Cost
Cost Per
Unit

Activity Level Activity Level

Note: 0 activity = 0 Total Variable Cost

ACC 204 Chapter 5 2

 Fixed Costs
Total Fixed Costs Fixed Costs Per Unit
do not change with vary inversely with
activity level activity level

Total Cost
Cost Per
Unit

Activity Level Activity Level

Note: Higher Activity Level = Lower Fixed Costs Per Unit

Relevant Range
Actual Total Variable and Total Fixed Costs are non-linear.
The Relevant Range is the range around the actual activity
level.
Total Variable Costs Total Fixed Costs

Total Total
Cost Cost

Activity Level Activity Level

Costs within the Relevant Range are assumed to be approximately linear.

ACC 204 Chapter 5 3

 Mixed Costs
Mixed Costs have a fixed and a variable component;
e.g., rental truck: $19.95 per day + $.50 per mile

Total Mixed Costs Mixed Costs Per Unit

Variable
Total Cost Cost
Cost Per
Fixed Cost Unit

Activity Level Activity Level

Note: 0 activity = Fixed Component (not 0 as in variable cost)

Hi-Lo Method for Mixed Costs

The Hi-Lo Method is a technique for estimating
the fixed and variable cost components in a mixed
cost.
There are 4 steps:
1 - Identify High and Low Cost Activity Levels
2 - Calculate the difference in Cost and Activity
3 - Calculate the Variable Cost Per Unit
4 - Calculate the Fixed Cost

ACC 204 Chapter 5 4

 Hi-Lo Method for Mixed Costs
Step 1 –
Identify High and Low Cost Activity Levels

Total
Month Cost Activity
January $ 30,000 20,000 Low Cost
February $ 48,000 40,000
March $ 49,000 35,000
April $ 63,000 50,000 High Cost

Hi-Lo Method for Mixed Costs

Step 2 – Calculate the difference in Cost and
Activity

Hi Cost - Lo Cost = Difference

Total Cost $ 63,000 $ 30,000 $ 33,000

Activity 50,000 20,000 30,000

ACC 204 Chapter 5 5

 Hi-Lo Method for Mixed Costs
Step 3 – Calculate the Variable Cost Per Unit

Hi Cost - Lo Cost = Difference

Total Cost $ 63,000 $ 30,000 $ 33,000
divided by
Activity 50,000 20,000 30,000
Variable Cost Per Unit = $ 1.10

Hi-Lo Method for Mixed Costs

Step 4 – Calculate the Fixed Cost
Hi Cost Lo Cost
Total Cost $ 63,000 $ 30,000
Variable Cost:
$ 1.10 * 50,000 = 55,000
$ 1.10 * 20,000 = 22,000
Fixed Costs (Total – Variable) 8,000 8,000

Must Equal

ACC 204 Chapter 5 6

 Cost-Volume-Profit (CVP) Analysis
Financial Accounting CVP
Income Statement Income Statement
Sales Revenue
Sales Revenue
- Variable Costs
- Costs
= Contribution Margin

- Fixed Costs
= Net Income
= Net Income

Cost-Volume-Profit (CVP) Analysis

Total $ Per Unit* Ratio

Sales Revenue $ 800,000 $ 500

- Variable Costs 480,000 300

= Contribution Margin 320,000 200 40%

- Fixed Costs 200,000 Cont. Margin

=
= Net Income $ 120,000 Sales Revenue

* 1,600 Units

ACC 204 Chapter 5 7

 Target Income Analysis
Target Income Analysis uses the information
from the CVP analysis to calculate the level of
sales (dollars or units) required to achieve a desired
net income level.

Breakeven Analysis is a special case where target

income equals zero.

Target Income Analysis

Mathematical Approach:
Sales Variable
Revenue Costs
(1) - - Fixed Costs = Net Income
Q * Price Q * VC

(2) + Fixed Costs + Fixed Costs

Sales Variable
Revenue Costs
(3) - = Fixed Costs + Net Income
Q * Price Q * VC

ACC 204 Chapter 5 8

 Target Income Analysis
Mathematical Approach:
Sales Variable
(3) Revenue Costs = Fixed Costs + Net Income
-
Q * Price Q * VC

Fixed Costs + Net Income

(4) Q * Price - VC =

(5) Q * Price - VC = Fixed Costs + Net Income

Price - VC Price - VC

Target Income Analysis

Mathematical Approach:

(5) Q * Price - VC = Fixed Costs + Net Income

Price - VC Price - VC

(6) Fixed Costs + Net Income

Q =

Price - VC

Contribution Margin
Per Unit

ACC 204 Chapter 5 9

 Target Income Analysis
Example: How many units must be sold to
generate $ 120,000 Net Income?

Fixed Costs Net Income

+ $ 120,000
$ 200,000
Q =
Price – VC
$500 – 300 = $ 200

Q = 1,600 Units

1,600 Units * $ 500 = $ 800,000 Sales Revenue

Target Income Analysis

Example: What is the Breakeven Point (i.e., Net
Income = 0) in Units and Dollars?

Fixed Costs Net Income

+ $0
$ 200,000
Q =
Price – VC
$500 – 300 = $ 200

Q = 1,000 Units

1,000 Units * $ 500 = $ 500,000 Sales Revenue Breakeven

ACC 204 Chapter 5 10

 Target Income Analysis
Contribution Margin Ratio Technique Example:
What is the Breakeven Point in Units and Dollars?

Fixed Costs Net Income

+
Sales $ 200,000 $0
=
Revenue
Contribution Margin Ratio
40%
Sales
= $ 500,000 Breakeven
Revenue
$ 500,000 / $ 500 = 1,000 Units Breakeven

Margin Of Safety
The Margin of Safety is the difference between the
current level of sales and the breakeven level, i.e., it
tells you how much sales can decline before you
start to lose money.

Sales $ Units
Current Sales $ 800,000 1,600
- Breakeven 500,000 1,000
= Margin of Safety 300,000 600

ACC 204 Chapter 5 11